Cracks quickly appear in euro plan

The €1 trillion ($1.34 trillion) bailout to save the European Union’s single currency is in danger of unravelling after Germany’s central bank warned that the rescue measure is too dependent on the type of high-risk deals that caused the economic crisis.

The trouble emerged as the euro zone sent one of its chief officials to China to seek an input of cash to help stabilise Europe’s slowing economy and debt crisis.

The head of the euro zone bailout fund went to Beijing on Friday as Europe tried to persuade China and other top emerging economies to come to its rescue. Klaus Regling, chief executive of the European Financial Stability Facility (EFSF), was in the Chinese capital before travelling to Japan on the weekend.

EU leaders are set to sanction the establishment of a so-called special purpose investment vehicle, or SPIV, to be set up in the coming weeks. It aims to attract funds from China and Brazil, among others.

The first signs of difficulty for the deal emerged just hours after an all-night summit of euro governments ended, as flaws began to emerge in a package billed as a “grand and comprehensive" solution to the European debt crisis.

The concerns were led by Germany’s powerful central bank, which expressed fears that a plan to leverage a €440 billion ($590 billion) euro zone rescue fund to amass a “fire power" of €1 trillion resembled the risky finance methods that triggered the crisis in 2008.

Bundesbank president and European Central Bank member Jens Weidmann sounded the alarm over the plan to “leverage" the fund by a factor of four to five times without any new money being put in the pot. He warned that the scheme could be hit by market turbulence and taxpayers left with the bill for risky investments in Italian and Spanish bonds. “It is tied to higher risks of losses and to increased sharing of risks," Mr Weidmann said. “The way they are constructed, the leveraging instruments are not too different from those which were partly responsible for creating the crisis, because they concealed risks."

Bill Gross, founder of Pimco, the world’s largest bond fund, said the rescue would be a temporary fix for markets and the fund could pose a high risk for investors.

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“No bazooka but should stabilise markets for now," he messaged on Twitter. “Watch out if the plan is a giant SIV [structured investment vehicle] with levered risk." Economists attacked the plan to raise the EFSF to €1 trillion on paper as not enough to “stave off" worsening debt problems in Italy and Spain. In a survey, 26 of 48 economists thought the fire power was not enough. A plan for a €2 trillion fund was shelved after German and French opposition.

Capital Economics’ Jonathan Loynes said the plan looked “more like a peashooter than the bazooka previously promised to tackle the region’s problems".

“We have not altered our view that the crisis will deepen over the coming quarters, ultimately resulting in some form of break-up of the currency union," he said.

Citi’s Guillaume Menuet said it was “a step in the right direction, but we do not expect it to calm markets permanently".

Doubts have also emerged over the lack of detail on how Greece will negotiate a voluntary “haircut" to let it to write off about half its debt.

Private sector banks agreed to start negotiations on a nominal 50 per cent cut in bond investments to cut Greece’s debt burden by €100 billion, reducing its debt from 160 per cent to 120 per cent of GDP by 2020. At the same time, the euro zone will offer €30 billion of sweeteners to the private sector.

Senior EU officials were left admitting that there was no agreement on how the deal would translate into a reduction in the Greek debt.